Inventory is an integral part of many companies' day-to-day business operations. The quantity of product a business has on hand appears on the balance sheet as an asset. Companies that maintain inventory need to know how much of it they have and how much it is worth.

This knowledge about their inventory makes it possible for companies to plan efficiently when it comes to their finances.

Many companies need inventory to do business; a company cannot sell what it doesn't have. Being knowledgable of inventory levels is essential to ensure these businesses run efficiently.

Importance of Inventory Management

Inventory management is one of the primary ways a company maximizes potential sales. When a company doesn't maintain an adequate level of inventory, it puts itself in a position to lose out on sales or customers.

If a company carries too much inventory, it runs the risk of the inventory becoming outdated or losing it to spoilage.

This is particularly true in industries such as agriculture. Having to throw away products because they spoiled becomes expensive for companies when it happens frequently.

Inventory Equals Money

The simple truth behind any business is that it must make money to survive. While some companies – those that provide services only – can operate without inventory concerns, most businesses rely on selling a product to make money.

Not only is having inventory essential to making sales, but it is also crucial for companies to plan and budget financial expenditures effectively.

Assume a T-shirt company knows that it has three months of inventory in stock and is currently in debt. The company may choose to pay off some of the debt because it knows it has a few months before it must buy more shirts. If that same T-shirt company knows that it has only enough inventory for a couple of weeks, it may postpone certain expenses – such as debt repayment – to buy additional inventory that it needs to keep cash flow steady.

Customer Satisfaction and Loyalty

Maintaining a proper inventory level ensures that when customers want a product, the company can provide it. Customers don't care about the logistics behind inventory management; their concern is that a company has whatever they want when they want it.

When a company sells out of a product a customer wants, that customer will likely take their business elsewhere. While this may only result in one lost sale, a company runs the high risk of losing that customer permanently to a competitor.

Suppose a restaurant tries to order $500 in utensils from a company, but the company is out of stock. If this happens repeatedly – or even once – the restaurant will likely choose a different supplier. If the restaurant buys $500 in utensils every month, this amounts to a loss of $6,000 in potential sales for the company.

This loss is from one restaurant. If several restaurants try to buy utensils from the same company but cannot due to inventory issues, the losses will be much higher.

Measuring Company Efficiency

Maintaining consistent levels of inventory gives companies a good idea of how their businesses are running. Cash flow measures the money coming in and going out of a business and is a good indicator of how efficiently the business is operating.

An excessive amount of inventory reduces a company's cash in because it is not making sales on what is sitting in the warehouse. A lack of inventory also keeps the company from bringing in revenue because there is nothing to sell.